Chapter 2 The Regulatory Framework

Answer 1 Stock Exchange A quoted company is a company whose shares are bought and sold on a stock exchange. This involves the signing of an agreement which requires compliance with the rules of that stock exchange. This would normally contain amongst other things the stock exchange's detailed rules on the information to be disclosed in quoted companies' accounts. This, then, is one regulatory influence on a quoted company's accounts. The stock exchange may enforce compliance by monitoring accounts and reserving the right to withdraw a company's shares from the stock exchange: ie the company's shares would no longer be traded through the stock exchange. n many countries there is, however, no statutory requirement to obey these rules. Local legislation n most countries, companies have to comply with the local companies legislation, which lays down detailed requirements on the preparation of accounts. !ompany law is often quite detailed, partly because of external influences such as "# $irectives. Another reason to increase statutory regulation is that quoted companies are under great pressure to show profit growth and an obvious way to achieve this is to manipulate accounting policies. f this involves breaking the law, as opposed to ignoring professional guidance, company directors may think twice before bending the rules % or, at least, this is often a government's hope. Standard setters &rofessional guidance is given by the national and international standard'setters. &rescriptive guidance is given in accounting standards which must be applied in all accounts intended to show a 'true and fair view' or 'present fairly in all material respects'. nternational (inancial )eporting *tandards and national standards are issued after extensive consultation and are revised as required to reflect economic or legal changes. n some countries, legislation requires details of non'compliance to be disclosed in the accounts. '$efective' accounts can be revised under court order if necessary and directors signing such accounts can be prosecuted and fined +or even imprisoned,. The potential for the A*-'s influence in this area is substantial. t must pursue excellence in standards with absolute rigour to fulfil that potential.

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Answer 2 !a" The users of financial information % creditors, management, employees, business contacts, financial specialists, government and the general public % are entitled to information about a business entity to a greater or lesser degree. 0owever, the needs and expectations of these groups will vary. The preparers of the financial information often find themselves in the position of having to reconcile the interests of different groups in the best way for the business entity. (or example whilst shareholders are looking for increased profits to support higher dividends, employees will expect higher wage increases1 and yet higher profits without corresponding higher tax allowances +increased capital allowances for example, will result in a larger tax bill. 2ithout accounting standards to prescribe how certain transactions should be treated, preparers would be tempted to produce financial information which meets the expectations of the favoured user group. (or example creative accounting methods, such as off balance sheet finance could be used to enhance a company's statement of financial position to make it more attractive to investors3lenders. The aim of accounting standards is that they should regulate financial information in order that it shows the following characteristics. +i, )elevance +ii, )eliability +iii, #nderstandability +iv, !omparability !#" A number of reasons could be advanced why the financial statements of not'for'profit entities should not be sub4ect to regulation. They do not have shares that are being traded, so their financial statements are not produced with a share price in mind. They do not have chief executives with share options seeking to present favourable figures to the market. They are not seeking to make a profit, so whether they have or not is perhaps irrelevant. They are perceived to be on slightly higher moral ground than profit'making
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entities, so are less in need of regulation. 0owever a closer look at this brings up the following points. !harities may not be invested in by the general public, but they are funded by the public, often through direct debits. !harities are big business. n addition to regular public donations they receive large donations from high'profile backers. They employ staff and executives at market rates and have heavy administrative costs. *upporters are entitled to know how much of their donation has gone on administration. Any misappropriation of funds is serious in two ways. t is taking money from the donating public, who thought they were donating to a good cause, and it is diverting resources from the people who should have been helped. 5ot all charities are bona fide. (or instance, some are thought to be connected to terrorism. (or these reasons, it is important that the financial statements of not'for'profit entities are sub4ect to regulation. Answer $ !a" Functions o% #odies within &ASCF n recognition of the increasing importance of international accounting standards, in /666 the -oard of the A*- recommended and subsequently adopted a new constitution and structure. After a two year process a new supervisory body, The nternational Accounting *tandards !ommittee (oundation, was incorporated in the #*A in (ebruary .77/ as an independent not'for'profit organisation. t is governed by .. A*! (oundation Trustees who must have an understanding of international issues relevant to accounting standards for use in the world8s capital markets. The main ob4ectives of the A*! (oundation are: to develop a single set of global accounting standards that require high quality, transparent and comparable information in financial statements to help users in making economic decisions1 to promote the use and application of these standards1 in fulfilling the above two ob4ectives, to take account of the special needs of small and medium si9ed entities and emerging economies1 and to bring about convergence of national accounting standards and international
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accounting standards The subsidiary bodies of the A*! (oundation are the nternational Accounting *tandards -oard + A*-, +based in ;ondon #<,, the *tandards Advisory !ouncil +*A!, and the nternational (inancial )eporting nterpretations !ommittee + () !,. The &nternational Accounting Standards 'oard The result of a restructuring process saw the A*- assume the responsibility for setting accounting standards from its predecessor body, the nternational Accounting *tandards !ommittee. The Trustees appoint the members of all of the above bodies. They also set the agenda of and raise finance for the A*-1 however the A*- has sole responsibility for setting accounting standards, nternational (inancial )eporting *tandards + ()*,, following rigorous and open due process. The Standards Ad(isory Council provides a forum for experts from different countries and different business sectors with an interest in international financial reporting to offer advice when drawing up new standards. ts main ob4ectives are to give advice to the Trustees and A*- on agenda decisions and work priorities and on the ma4or standard'setting pro4ects. The &nternational Financial Reporting &nterpretations Committee has taken over the work of the previous *tanding nterpretations !ommittee. t is really a compliance body whose role is to provide rapid guidance on the application and interpretation of international accounting standards where contentious or divergent interpretations of international accounting standards have arisen. t operates an open due process in accordance with its approved procedures. ts pronouncements +interpretations % * !s and () !s, are important because financial statements cannot be described as complying with ()*s unless they also comply with the interpretations. )ther 'odies The prominence of the A*- has been enhanced even further by its relationship with the nternational =rganisation of *ecurities !ommissions + =*!=,. =*!= is an influential organisation of the world8s security commissions +stock exchanges,. n /66> the A*! agreed to develop a core set of standards which, when endorsed by =*!=, would be used as an acceptable basis for cross'border listings. n ?ay .777 this was achieved. Thus it can be said that international accounting standards may be the first tentative steps towards global accounting harmonisation. As part of its harmonisation process the "uropean #nion requires that all listed companies in all
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member states prepare their financial statements using ()*s. 5ational standard setters such as the #<8s Accounting *tandards -oard and the #*A8s (inancial Accounting *tandards -oard have a role to play in the formulation of international accounting standards. *even of the leading national standard setters are members of the A*-. The A*- see this as a ApartnershipB between A*- and these national bodies as they work together to achieve the convergence of accounting standards world wide. =ften the A*- will ask members of national standard setting bodies to work on particular pro4ects in which those countries have greater experience or expertise. ?any countries that are committed to closer integration with ()*s will publish domestic standards equivalent +sometimes identical, to ()*s on a concurrent timetable. !#" The &nternational Accounting Standard Setting *rocess As referred to above the A*- is ultimately responsible for setting international accounting standards. The -oard +advised by the *A!, identifies a sub4ect and appoints an Advisory !ommittee to advise on the issues relevant to the given topic. $epending on the complexity and importance of the sub4ect matter the A*- may develop and publish $iscussion $ocuments for public comment. (ollowing the receipt and review of comments the A*- then develops and publishes an "xposure $raft for public comment. The usual comment period for both of these is ninety days. (inally, and again after a review of any further comments, an nternational (inancial )eporting *tandard + ()*, is issued. The A*- also publishes a -asis for !onclusions which explains how it reached its conclusions and gives information to help users to apply the *tandard in practice. n addition to the above the A*- will sometimes conduct &ublic 0earings where proposed standards are openly discussed and occasionally (ield Tests are conducted to ensure that proposals are practical and workable around the world. The authority of international accounting standards is a rather difficult area. The A*has no power to enforce international accounting standards within those countries3entities that choose to adopt them. This means that the enforcement of international accounting standards is in the hands of the regulatory systems of the individual adopting countries. There is no doubt the regulatory systems in different parts of the world differ from each other considerably in their effectiveness. (or example in the #< the (inancial )eporting )eview &anel +())&, is a body that investigates departures from the #<8s regulatory system +which will soon include the
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use of international accounting standards for listed companies,. The ())& has wide and effective powers of enforcement, but not all countries have equivalent bodies, thus it can be argued that international accounting standards are not enforced in a consistent manner throughout the world. !omplementary to international accounting standards, there also exist international auditing standards and part of the rigour and transparency that the use of international accounting standards brings is due to the fact that those companies adopting international accounting standards should also be audited in accordance with international auditing standards. This auditing aspect is part of =*!=8s requirements for financial statements to be used for cross'border listing purposes. 2here it becomes apparent +often through press reports, that there is widespread inconsistency in the interpretation of an international accounting standard, or where it is perceived that a standard is not clear enough in a particular area, the () ! may act to remedy3clarify the position thus supplementing the body of international standards. 0owever where it becomes apparent +perhaps through a modified audit report, that a company has departed from ()*s there is little that the A*- can do directly to enforce them. n .77C the A*- has stated that all new standards will be reviewed after a two year period, to ensure that the standard is fulfilling its stated ob4ective and that there are no undue concerns in the application of the standard. !c" The success o% the process acceptance of ()*s through =*!=8s endorsement, the "uropean #nion requirement for their use by listed companies and the ever increasing number of countries that are either adopting international accounting standards outright or basing their domestic standards very closely on ()*s is a measure of the success of the A*-. "qually there is widespread recognition that in recent years the quality of international accounting standards has improved enormously due to the improvements pro4ect and subsequent continuing improvements. 0owever the A*- is not without criticism. *ome countries that have developed sophisticated regulatory systems feel that ()*s are not as rigorous as the local standards and this may give cross'border listing companies an advantage over domestic companies. *ome requirements of international accounting standards are regarded as quite controversial, e.g. deferred tax +part of A* /.,, financial instruments and derivatives + A* :. and :6, and accounting for retirement benefits + A* /6,. ?any ()*s are complex and the
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benefits of applying them to smaller entities may be outweighed by the costs, the A*- has issued an exposure draft aimed at small and medium si9ed companies. Also some securities exchanges that are part of =*!= require non'domestic companies that are listing by filing financial statements prepared under ()*s to produce a reconciliation to local EAA&. This involves reconciling the ()* statement of comprehensive income and statement of financial position, to what they would be if local EAA& had been used. The #*A is an important example of this requirement, although it has been announced that the requirement to reconcile to #* EAA& will no longer be required for those companies complying with ()*. !ritics argue that this requirement negates many of the benefits of being able to use a single set of financial statements to list on different security exchanges. This is because to produce reconciliation to local EAA& is almost as much work and expense as preparing financial statements in the local EAA& which was usually the previous requirement. $espite these criticisms there is no doubt that the work of A*- has already led, and in the future will lead, to further improvement in financial reporting throughout the world.

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